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Euro Bonds Explained

Euro bonds have been touted as a magical solution to the European Debt crisis. I myself have struggled for a long time to full grasp exactly what euro bonds are. Thankfully, CNN Money have put out the following article that articulately summarizes the point behind euro bonds.

Essentially, euro bonds are just like any other bond except it is in Euros. This means that countries or organizations issuing the bond borrows money from people who buy the bond and promises to pay them back at a given interest rate at some point in the future. The point of a Euro bond is that in-debt countries can share their debt with other countries, allow the euro zone to not only “share a common currency, but a common debt load.”

Full article below:

Many key European nations share a common currency, but not a common debt load. That has to change. Now.

The European financial crisis is intensifying. And that’s why some experts are calling for new bonds denominated in euros. The hope is that a shared debt security could help lower the borrowing costs for the debt-laden PIIGS nations of Portugal, Ireland, Italy, Spain and Greece.

abysmal rate of growth in the euro zone shows that something drastic needs to be done to salvage the euro currency.

The European Financial Stability Facility, essentially a bailout fund for the PIIGS, has failed to end the crisis. Neither has a European version of the Fed’s quantitative easing program — which will buy up bonds of the most troubled European nations.

The supposedly strong nations of Germany, France and the Netherlands all posted anemic economic growth in the second quarter. That’s proof that the malaise has spread beyond the PIIGS.

French president Nicolas Sarkozy and German Chancellor Angela Merkel met Tuesday to discuss ways to staunch the bleeding in Europe. Both leaders pledged to work even more closely to try and fix what ails the continent. But they ruled out the idea of issuing euro bonds right now.

Some of the stronger nations in Europe, particularly Germany and the Netherlands, had not been fans of the euro bond idea.

While a common euro bond could mean lower interest rates for the nations with the worst debt problems, that could drive up rates in the more fiscally responsible European countries. And bailout fatigue is already rising in parts of Europe after the aid packages for Greece, Portugal and Ireland.

Still, there is a growing sense that Merkel and other German politicians may be slowly realizing that the positives of a euro bond outweigh the negatives.

Europe stock markets ease as growth stalls
For one, anything that can be done to keep the euro currency intact is a good thing for Germany and other more stable European nations, argues Benjamin Reitzes, senior economist and foreign exchange strategist with BMO Capital Markets in Toronto.

“Without a larger solution, this crisis could mean the end of the euro,” he said. “If there was no euro, Germany’s currency would skyrocket and its exports would be hit. Germany does benefit from the euro.”

In other words, bringing back the Deutsche mark would likely lead to Germany facing the same problems as Switzerland. The Swiss government has been forced to intervene in the currency markets several times to rein in the strength of its surging franc.

The Swiss franc has become a safe haven for investors worried about debt problems in Europe and the United States. And while a vibrant currency sounds like a good problem to have, when it is too strong it hurts exports because it makes foreign goods cheaper.

Frances Hudson, global thematic strategist with Standard Life Investments in Edinburgh, Scotland, agreed that Germany needs the euro as much as the euro needs it.

She added that all the gloomy headlines about the fiscal fate of Europe only makes matters worse for the stronger euro zone nations. Hudson thinks that some German companies are likely urging the government to take more decisive action to once and for all end the crisis of confidence.

“Everyone is suffering from the financial markets being roiled by all the uncertainty,” she said. “The weaker economic picture for Germany and France and slow growth across the euro zone only increases the pressure to set up a euro bond structure.”

It’s stunning to think that it’s taken this long (and a major financial calamity) before experts finally came to the realization that a euro bond, a debt security that would be denominated in euros, issued by the European Central Bank and backed by the EU member nations, makes sense.

Think about it. The way that the EU currently operates is like a married couple with only two individual bank accounts and no joint account. I guess that could work for awhile. But you’re only asking for trouble in the long run if the finances are kept separate.

“The way for the euro to survive and become stronger is further integration,” said Vassili Serebriakov, currency strategist with Wells Fargo in New York. “Whether that will take the form of a euro bond now is really hard to say. But down the road you would think that’s something that would work.”

At the end of the day, it’s chaotic to have bond yields between various European nations diverge so wildly. (See chart above.) Anything that can keep long-term yields of the five PIIGS from skyrocketing much further would be good for all of Europe.

“A euro bond can help the countries that are having trouble raising money from the financial markets. As a backstop, it could improve matters for Italy and Spain,” said Hudson.

“Europe needs joint fiscal policy and euro bonds would help alleviate some of the concerns,” he said. “Even in Greece, issuing euro bonds could help them buy up their own debt at below market prices so they can maybe ease some austerity measures.”

The failure by European politicians and financial leaders to make the kind of aggressive and coordinated move that the markets want could have dire consequences.

“It seems that until Europe’s back is against the wall, nobody wants to take bold action,” Reitzes said. “But if investors push rates high enough throughout Europe, then more countries may need a bailout no matter what. The markets may have the power to break up the euro.”

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.